What’s driving our sharemarket down? A SmartCompany Q&A

The bad news just keeps coming for investors. The Australian sharemarket crashed to its lowest point in more than five years yesterday, with the benchmark S&P/ASX 200 index falling 2.8% to 3250.1 points. Overnight, Wall Street’s key Dow Jones Industrial Average plunged 4.2% to a 12-year low.

Both markets are now below the depths seen last November, when it appeared the global banking system could be on the brink of collapse. But what is driving this fresh wave of negative sentiment?

Time for a SmartCompany Q&A.

I thought 2009 was going to be a better year for sharemarkets. What’s happened?

The traditional New Year optimism of investors didn’t last long. Since 1 January, the ASX200 has fallen 10.1%, after plummeting by 40.1% during 2008. Over in the US, the Dow Jones Industrial Average has fallen almost 20% since the start of the year, after falling 33% last year.

But I thought governments and central banks stepped in to shore up the global financial system last year. Now the markets are telling us things have got worse, not better.

While the actions of governments in the US, Britain and Australia have made the position of the banking system more secure, the deep problems of individual banks have still not been resolved. Throughout Europe and the US, banks remain saddled with huge debts and mounting losses and are desperate for fresh capital. Some are trying to raise money from investors while many will be forced to turn to governments for bailouts.

To make matters worse, we still don’t really know how bad the problems are inside these banks. The value of complex derivative products such as collateralised debt obligations (CDOs) has masked the true state of bank balance sheets around the globe. Investors are scared of what they can’t see or understand, and who can blame them.

But the Australian banks are in good shape, aren’t they?

They certainly are, relative to their overseas counterparts. But even in Australia the banks are seeing bad debts start to rise and profit growth start to slow. Yesterday rating agency Moody’s Investors Service downgraded the rating outlook for the ANZ, Commonwealth Bank and Westpac to negative. While the banks are a long way from losing their AA credit rating, it’s not a good look.

What are some of the other factors weighing on our market?

Obviously the threat of recession is affecting different share prices in different ways. Most industrial companies (such as manufacturers and building products companies) are being hammered as demand for these products falls. Investors want nothing to do with property companies, most of whom are carrying large amounts of debt. Media companies are no-go zones, and resources stocks remain under pressure as commodity prices slide.

Right, so pretty much every company is being sold off. Doesn’t that mean shares are starting to look cheap?

They certainly are by historical perspectives. The long-term historical price-to-earnings multiple of the Australian sharemarket is 14.5, but the market is currently trading on a P/E of less than 10, which indicates shares are very cheap.

But many investors hanging back from buying and are asking themselves “what if shares keep falling and they get even cheaper?”.

So will shares get cheaper? How low could the market fall?

Absolutely no idea. Now that the market has fallen through the low point set last year, quite where the bottom lies is anybody’s guess. Experts who had predicted a recovery in share prices in the second half of the year are revising these estimates – investors are telling us they think the economic downturn is likely to be longer than we first thought, and this will also delay any recovery in sharemarkets.

The only certainty is a lot more volatility in the short term. The further falls on Wall Street last night send a clear message – while the bad news continues, the sharemarket will continue to fall.

Related articles:

• What the Wall Street crises means for the Australian economy
• The CDO timebomb – how it works and why it could sink or save the world economy